Weekly Latin America Risk Monitor: Growth Remains Constrained

Conclusion: Both financial markets and economic data continue to paint a negative intermediate-term outlook for the Latin American region.



Latin American equity markets had another off week last week, closing down -2.4% on a median basis. Argentina, a market we remain the most bearish on, led decliners (-8.1% wk/wk) and is now down -28.3% for the YTD. Latin American equity markets are down -17.9% YTD on a median basis as economic stagflation erodes earnings and equity multiples to varying degrees throughout the region.


Latin American currencies also struggled against King Dollar last week, closing down -1% wk/wk on median basis. Brazil’s real and Chile’s peso led decliners, falling over -2% each.


Across Latin American sovereign debt and interest rate markets, we saw Brazil continue to get the benefit of the doubt on the rate cutting front: 2yr yields declined -11bps wk/wk; 9yr yields declined -12bps wk/wk; and 1yr O/S interest rate swaps tightened another -5bps to 9.95% – a full -155bps below the central bank’s target Selic rate! Other sovereign issuers, including Mexico and Colombia saw their local currency yields back up broadly across the curve last week.


5yr CDS traded wider across the entire region last week, finishing +10.6% wider on a median percentage basis. Mexico led gainers here, closing up +13.7% or +21bps wider wk/wk. Mexico, whose equity market continues to benefit from hopeful expectations out of the U.S., may be suggesting things aren’t as rosy north of the border as they are expected to appear – at least according to the credit market’s perspective. Mexican 5yr CDS has widened +55.6% in the YTD, which is right in line with the +56% median YTD move in the region.



Growth Slowing:

  • Despite consumer credit growth running well beyond central bank targets in the YTD (up ~29%) Brazil’s central bank unwound the bulk of consumer credit curbs it imposed last December in what appears to be desperate effort to spur growth and “ward off recession” according to public rhetoric. Specifically, the measures reduced capital requirements for auto loans w/ maturities of less than 5yrs and maintained a 15% monthly minimum payment requirement on consumer loans that was scheduled to increase to 20% by EOY. The moves have marginally slowed down the rate at which traders expect the central bank to ease monetary policy, though further cuts are still being priced into various markets.
  • Brazil’s economic activity index, a proxy for GDP, slowed in Sept to +1.2% YoY vs. +2.9% prior.
  • Brazilian formal payrolls growth slowed in Oct to 126.1k vs. 209.1k.
  • Chilean real GDP growth slowed in 3Q11 to +4.8% YoY vs. +6.6% prior.
  • Peruvian real GDP growth slowed in Sept to +5.8% YoY vs. +7.5%.

King Dollar:

  • Chile’s central bank kept its benchmark interest rate on hold at 5.25% for the fifth straight month last week. The move comes as CPI accelerated to a 2-plus year high of +3.7%, which is pushing toward the outer limits of the central bank’s target band (3% +/- 100bps). The fact that they didn't raise rates signals to us that their "balance of risks analysis" is skewed towards eventually needing to take steps to preserve growth (i.e.: cut rates).
  • The yields on Argentina’s benchmark dollar-denominated bonds due in 2033 jumped +143bps to 13.67% amid growing speculation that the government’s efforts to support the peso will ultimately fail. Central bank reserves have fallen -12.2% to $46.2 billion amid dollar sales and a $5.7 billion allocation to service international debt. The government has taken extensive measures of late to combat capital outflows, which have forced benchmark deposit rates to 3yr highs and the highest level relative to interbank rates since 2003 (badlar = 20.6%; baibor = 12%). We’ve been quite bearish on Argentine equities, largely as a result of the long list of knock-on effects of a pending currency devaluation; email us for our aggregated work on this topic – not the least of which are higher borrowing costs leading to a deteriorating credit outlook. Fighting King Dollar’s bullish bid is not a battle we foresee the Argentines winning.


  • Mexican same-store sales growth accelerated in Oct to +5.8% YoY vs. +5.4% prior.

Darius Dale



Weekly Latin America Risk Monitor: Growth Remains Constrained - 1


Weekly Latin America Risk Monitor: Growth Remains Constrained - 2


Weekly Latin America Risk Monitor: Growth Remains Constrained - 3


Weekly Latin America Risk Monitor: Growth Remains Constrained - 4


Weekly Latin America Risk Monitor: Growth Remains Constrained - 5


Weekly Latin America Risk Monitor: Growth Remains Constrained - 6

Covering the Aussie Dollar – We’ll Be Back

Today, Keith used the red tape across global macro markets to book some gains on the short side in our Virtual Portfolio. Within that construct, we’ve covered the Aussie Dollar (etf: FXA) as it is finally immediate-term TRADE oversold on our quantitative factoring. Australia’s currency remains our top Asian FX short idea over the intermediate-term TREND due to the following factors: 

  1. The Reserve Bank of Australia, led by Glenn Stevens, looks to accelerate the pace of rate cuts over the intermediate term as both growth and inflation continue to slow alongside dramatic property market headwinds;
  2. Australia’s terms of trade – which are heavily associated with raw materials prices – will continue to decline from multi-generational highs as both demand for and market prices of Australia’s exports fall (Asia accounts for roughly 70% of Aussie exports, which are roughly 60% comprised of commodities like coal, iron ore, and liquefied natural gas)… the CRB Raw Industrial Materials Index is down -17.3% from its YTD peak;
  3. Mean reversion and Winner’s Risk (i.e. liquidation) remain headwinds on the behavioral side (AUD is the best performer globally vs. the USD since the March ’09 low in global beta – up +55.8%). 

Covering the Aussie Dollar – We’ll Be Back - 1


Covering the Aussie Dollar – We’ll Be Back - 2


Covering the Aussie Dollar – We’ll Be Back - 3


For those who haven’t seen the in-depth work behind our intermediate-term bearish thesis on the Aussie dollar, please refer to the following research notes for more details: 

Darius Dale



Covering the Aussie Dollar – We’ll Be Back - 4

Retail: 'Hope" Doesn't Work

I’m sure you’re all hearing the same news reports we are…that retailers are ‘hoping’ for a positive holiday season. The NRF (National Retail Federation) came out with its forecast for a 2.8% boost in Holiday Sales, which is not huge, but is certainly not a slam dunk either.


The reality is that when we YouTube the NRF’s forecast accuracy, we see that it missed plan (it overestimated) by about 1.6% on average over 10-years. But that only tells half of the truth. When we’re in a good economy, such as ’03, ’04, ’05 and ’06, the NRF is usually fairly accurate with its forecast. That’s kind of like saying that the Las Vegas weatherman usually gets the forecast about right the month of August (100+ with zero humidity).


But when the economy sees meaningful fluctuations (like when no one caught wind of the seriousness of that East Coast snowstorm in Oct), forecasts tend to be off very materially.


As outlined in the chart below, the NRF missed by 660bps in 2008 on the downside, and underestimated by 290bp in what was a positive snap-back in 2010.


3Q12 just capped off the fifth consecutive quarter where inventories grew faster than in sales in retail. So could we see upside to the NRF’s 2.8%. It’s possible, but we feel strongly that it would be at the expense of margin. Remember…all-in, (nearly) every last unit of apparel will be sold by the end of the season. It’s simply a function of how far down the pricing curve the retailers will need to go in order to ring the register.


Retail: 'Hope" Doesn't Work - NRF Analysis

Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.


The easy call is to be negative on PFCB following the analyst day on Friday.  It’s also easy to get bullish.   


P.F. Chang’s is, in some ways, a victim of its own success.  For most of its life as a public company, the company’s core concept, PF Chang’s has been a concept that has produced very high unit level economics and has operated in the Asian category without any real competition.  Over time, this has led the company to become “fat and happy”.  The concept’s issues can be traced back to 2007 but, the sluggish economy has somewhat masked those problems.  As the economy has expanded and other concepts have seen an improvement in trends, P.F. Chang’s has lagged.  If I have one criticism of management that stands above all others, it is that it does not reflect well upon them that the company is only now getting around to focusing on consumer research and the performance of its company excluding any macro drag.  The excerpt below, from the transcript of the meeting, illustrates what we mean.  It should not take a crisis for the company to be moving in the direction that it is now aiming for.


“One of the things that will be sort of a common theme through today's presentations is, as an organization we've moved from being, I would say, being a little more intuitive to more fact based in terms of our decision making. I mean over the years I think we've – we've tended to be, we tended to have a really good understanding of the industry, a real good understanding of the consumer and our consumer. And we are augmenting that now with a wide variety of actual fact based research studies.”



That said, if the company is heading in the right direction and the stock has been beaten down (which it has), surely it is a Buy here?  There seems to be a light at the end of the tunnel but, of course, timing is everything and it is unclear how bright the light is.


Three key point to the Bullish case:

  • Strong assets and balance sheet, strong cash flow and international growth opportunities
  • Perennial PE target
  • Valuation

Three key point to the Bearish case:

  • EPS estimates are too high for 2012.  In our view, $1.50 in EPS for 2012 is likely and 2013 could also be disappointing in terms of earnings growth.
  • It is expensive to bring back the lapsed user and give food away to the loyal customer.
  • Valuation (trap)


Valuation can be bullish and bearish at the same time; PFCB is a perfect example of this.  From our seat, we feel that it is cheap for a reason.   We would be willing to bet that estimates are too high because it’s likely going to cost more than expected to turn the ship around.  It can be fixed, but just when the valuation trap will turn into a cheap valuation remains to be seen.  We don’t think it happens in the next three months at least.


In the interim the key things to focus on are as follows, along with our take on each:


1. Is management on the right track?

HEDGEYE: We believe so but, again, it is disconcerting that what other industry players have been utilizing for a long time is only being integrated in PFCB’s process now.  Performance of P.F. Chang’s brand will be the yardstick to measure how management is performing.


2. How long is it going to take?

HEDGEYE: We estimate two years; management says 2012 is the transition year with high inflation and “wild card” revenue.  2013 will also see a rising cost structure.


3. How expensive will it be to fix the problems, assuming they can be fixed?

HEDGEYE: Very.  These undertakings are difficult to get right the first time as well.


Unfortunately there are a lot of variables that are not within their control.  As management said last week the "revenue" outlooks is the “wild card” and are unsure of the outcome from the new initiatives the company is embarking on.  The road to remedying what ails the P.F. Chang's brand is filled with pot holes.  The brand has very loyal customer base, but uncertainties remain around how exactly the company is going to bring back the lapsed user.  As we view it, the new “Strategic Platform” they laid out is all about increasing costs and there was no talk of where they might be able to increase efficiencies. 



The PF Chang’s “Strategic Platform” to brand revitalization looks like this:

  1. Eliminate barriers to entry.  No entry level pricing on the menu and pricing at lunch needs to come down.
  2. Elevate the guest experience.  Management has added 150 basis points back to the labor line and the brand is in need of an extensive remodel program to serve good food in a clean, inviting atmosphere.
  3. Operate “with a fanatical focus on guest satisfaction” (same as the second point).  They have opened a new store in Providence RI with a new look and feel.  There will be 5-8 remodels in 2012.
  4. Communicate with the guest: “We want you back”. The dilemma for the company is that the P.F. Chang’s brand does not have the density to achieve a national message via television.  The alternative is an increased social media exposure and a revamp of the loyalty program. The current loyalty program gives the guest a 10% discount.  The company said last week they will be moving to a “surprise and delight” loyalty program (like PNRA). 


One the biggest challenges that the company faces is bringing people back at lunch.  There is a real price/value issue at lunch with only a 20% difference between lunch and dinner average check.  As management says “people think we are serving dinner at lunch”.  At dinner, customers share entrees but the lunch menu is not designed in a way that facilitates sharing.  The current average check at lunch is $17 and to be competitive it needs to be reduced by $2, according to management.   We contend that management is being conservative in this regard; $13 is likely a better level given that many big players in casual dining make lunch available for less than $10.  So the dilemma is that with 30% of the business coming at lunch and the concept looking at a $3-$5 decline in the average check, can management menu-engineer items that can survive that type of decline?


I was shocked to learn that the loyal user of P.F. Chang’s comes four times per year; I would have thought it was much more.  So, how do you bring in new customers (hopefully younger customers) while at the same time keeping the existing loyal costumer from spending less when they walk in the door? 


I don’t want to discount the potential for Pei Wei but management’s strategy for this brand is very confusing.  Their consumer research says that Pei Wei also has a price/value problem, and they have recently introduced “selects” with a lower price point to help the sales problem.  While it’s still early, sales trends have improved, and management said there has been very little erosion in the average check. 


All that being said the company’s commentary on the introduction of the Pei Wei Asian Market was confusing.   The new concept (another version of Pei Wei) is geared to a have 500 bps better margins, lower price points, reduce labor costs, flexible floor plan, reduced square feet and more portable food.


The new Pei Wei concept is geared to operate with significantly less labor costs.  So what does this say about the current Pei Wei concept of which, by the way, they are opening 16 new stores in 2012?  All I can say about Pei Wei is watch what they do not what they say!


I don’t want to buy a cheap stock on the “hope” that I get bailed out by some PE firm.  I also don’t want to short a stock that could fall prey to some activists or PE firm taking the company private.  Management tried to make a compelling case but, upon reflection, we are staying on the sidelines.   


The consumer is not dumb.  Restaurant companies with average check issues cannot manage margins and check in such a way that allows them to execute the business perfectly.  There is no reason to rush in.  Mr. Federico and team still have some work to do and there is much to be learned from the P.F. Chang’s of the future to be constructed in California.  The company had it too easy for too long.  Now there remains a lot of uncertainty and the onus is on management to reassure investors with results going forward.







Howard Penney

Managing Director


Rory Green







European Risk Monitor: Treading Water Won’t Save the Eurozone

Positions in Europe: Short France (EWQ); Short EUR-USD (FXE)

The status quo is not good enough. While heads have rolled in Greece, Italy, and Spain in recent days, and provided some short term bounces in specific capital markets, in our opinion a sustained bullish move will not come for European markets unless Eurocrats directly address: ( 1.) expansion (leverage) of the EFSF; (2.) bank recapitalizations (specifically for banks that cannot raise assets); and (3.) setting the rate of Greek haircuts to capture “voluntary” demand.


In the fray, however, remain much larger unanswered questions: Can EU treaties be amended to allow a country to leave or be kicked out of the Eurozone, but not the EU? Can Greece be ring- fenced as to not create a larger move of contagion across the 17 member states? Can a fiscal union work? Can the ECB’s SMP fend off rising yields in Spain and Italy, and will its secondary bond buying greatly expand and be deemed anything more than a temporary facility?


While there’s indication that Eurocrats (especially German Chancellor Angela Merkel at the top) want to maintain the existing fabric of the Eurozone and preserve the stability in the common currency, dialogue has shifted from top leaders and now core question like assessing if the unity of unequal states under one monetary policy is sustainable.  And while there’s renewed talks of Eurobonds (a position supported by George Soros) don’t discount political indecision across borders and fiscally stronger nations’ (Germany, Netherlands, Finland) resolve to reject them (at least initially) as to not see their cost of capital rise.


While we can’t get ahead of the actions politicians will take in the coming months, we continue to take our risk cues from the credit market.


Here we’ve seen yields across the periphery sustain elevated levels, and most worrisome are the recent breakouts in Spain and Italy, both now flirting around the 7% level on the 10YR, economies far larger than Greece, Portugal and Ireland combined, which cannot be contained in the case of a default or cracks across their sovereign debt and banking exposures given the existing size of the EFSF. We’ve also seen no change in the ECB’s position, backed by Germany, that it will directly intervene to support the region via leveraging the EFSF or buying primary issuance.


Given this “treading water” profile of inaction we’ll remain short the EUR-USD via the etf FXE in the Hedgeye portfolio, and remain short France (EWQ). We see the EUR-USD broken on its intermediate term TREND ($1.42) and long term TAIL ($1.40) levels. We’d expect the pair to TRADE over the immediate term TRADE between $1.33 and $1.35, and should it break its downside support level we do not see material support until the $1.21 line.


Below we present our weekly risk monitors.


European Equity and Currency Moves – On a week-over-week basis (Friday to Friday), European equity indices fell largely between -3% and -7%, with the outliers to the downside Austria (-7%, threatened by write off and banking exposure to Eastern Europe) and Cyprus -12.3%. Swiss equities were a relative outperformer, falling only -60bps w/w.  YTD notable equity indice declines include: Greece Athex -52%; Austria ATX -41%; Finland OMX -32%; Portugal PSI -31%; and Italy FTSE MIB -28%.   The EUR-USD finished down -1.6% w/w.


European Sovereign Yields – European 10YR yields were mixed last week. Greek yields declined -27bps; while Spanish yields gained +60bps and Italian +13bps.  As always, we’re keying off the 6% Lehman line as a critical breakout line. Italy and Spain are holding tight above the 6% for the last four weeks.


In its SMP bond purchasing program, the ECB bought €8 Billion in secondary bonds last week (vs €4.5B in the week prior), taking the total program to €194.5 Billion. Look for Super Mario (Draghi) to increase buying alongside heightening Italian yields.


European Risk Monitor: Treading Water Won’t Save the Eurozone - 1. yieldss


European Sovereign CDS – European sovereign swaps mostly widened last week. Spanish sovereign swaps widened by 8% (+36 bps to 463) and French by 12% (+25 bps to 227).


European Risk Monitor: Treading Water Won’t Save the Eurozone - 1  cds a


European Risk Monitor: Treading Water Won’t Save the Eurozone - 1. cds b


European Financials CDS Monitor – Bank swaps were wider in Europe last week for 39 of the 40 reference entities. The average widening was 8.1% and the median widening was 13.6%.

And just this morning Bank of Spain nationalized Banco De Valencia, a small Spanish bank, yet nevertheless is likely an initial sign of more to come. 


European Risk Monitor: Treading Water Won’t Save the Eurozone - 1. banks


Matthew Hedrick

Senior Analyst


Enter your email address to receive our newsletter of 5 trending market topics. VIEW SAMPLE

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.